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Thursday, 24 February 2011

Vertu Motors plc (VTU) claims to be the eighth largest motor retailer in the UK. The words 'retail', 'motor' and 'investment opportunity' do not always sit easily in the same sentence, so let's see if VTU has enough oomph to get into top gear or whether I've got a lemon on my hands.

Why Am I Interested?

1. The shares are trading at a 37% discount to reported net assets2. Directors have been buying in the last 12 months 3. Declared a maiden dividend in its interim results in October 20104. I have a holding at a break-even cost of 31p per share (acquired before my blog started)

Background

History & Operations

﻿﻿﻿﻿﻿﻿﻿VTU was formed in 2006 as a new vehicle to consolidate UK motor retailers, raising £25m and listing on AIM in December 2006. Since then, the Company has made numerous acquisitions and raised £56m through two Placings and has £45m in debt facilities (£12m drawn).

In essence, the strategy involves buying dealerships at reasonable prices and getting more out of them through applying "consistent business processes and systems" - ie increasing profits through harmonising and standardising as part of a larger corporate organisation - the whole is worth more than the sum of the parts kind of thing.

The Company is now present in over 70 locations, via 84 franchised and 3 non-franchised sales operations.

Activities include: new and used car sales, fleet contracts, commercial vehicles and 'after-sales' (servicing, repairs and parts). After-sales has by far the highest gross profit margins (41%) compared to new car sales (8%) and used car sales (10-12%).

The main brands sold include: Ford, Honda, Vauxhall, SEAT and Peugeot.

﻿﻿﻿﻿﻿﻿﻿﻿﻿﻿﻿The current share price of 28.5p (mid-point as at 23 February) gives the Company a market value of £57m. Based upon the 2010 basic EPS of 2.2p, this represents a PER of 12.8x.The Company is listed on AIM.

In the past five years, the shares have hit a high of 101.5p (Dec 2008) and a low of 10p (Feb 2007).

Source: London Stock Exchange

Risks & Challenges

- execution risk in a buy and build strategy - need to buy the right things at the right price;

- the motor "trade" is littered with the dead bodies of snake-oil salesmen. Anecdotally, the industry seems to have cleaned itself up a bit in the past decade, and maybe the consumer responds more favourably to a quality, corporate offering. One thing for sure, a profit is only a profit once it turns to cash;

- the sale of new (and used) cars is tied to some degree to economic well-being. The industry received some support via the government scrappage scheme, which ran from May 09 and was equivalent to the US's Cash for Clunkers scheme, but it remains a challenge. On the plus side, new car sales do not generate a huge amount of gross profit for the dealers, unlike servicing and maintenance, although you cannot have one without the other; and

Fancy a new motor?

- the Vertu business model is evolving and we do not have the benefit of a 10 year pedigree to analyse.

The Rules

The following analysis is based on the 12 months to 28 February 2010 (FY10) unless otherwise stated

1 - Assets - the NAV at February 10 was £90m compared to a market cap of £57m, equating to a discount of 37%. Better still, there was net cash of £23m, which if valued at par, means that you can buy £67m of assets for £34m - a discount of 50%.

Even if Goodwill of £21m and Cash are excluded, you can buy £46m of assets for £34m, which still represents a discount of 26%. The bulk of these assets are in relation to freehold and long leasehold sites. Pass

2 - Market Value - a market cap of £57m.Pass

3 - Cash Flow - (a) net current assets of £18m and (b) operating cash of £15m after working capital movements. Out of this, we need to cover replacement capex (£3m - est), interest (£1m) and tax (£1m - FY10 P&L), meaning that there is £10m "left over". Cash generation was also good in FY09 and it gives some comfort to see profits turn to cash. Pass

4 - Debt - (a) net cash of £23.5m and (b) Adjusted EV/EBITDA of 10x, which is a full valuation and probably reflects the asset nature of the business. This assumes that EBITDA is adjusted by £3m for replacement capex, which may be harsh for a growing business

Also, a word of caution in the FD's review re the cash balances:

The positive net cash balance at 28 February 2010 reflects the seasonal reduction in working capital, typical of the industry, which arises at the period end prior to a plate change month. Consequently, the year end net cash balance is higher than the normalised cash balances throughout the remainder of the year.

Unfortunately, he does not say what the normalised position would be.

5 - PER - based upon FY10 EPS of 2.23p, the current PER is 12.8x. The Company has only been listed for three financial years and has been growing through acquisition each year. The three year average EPS is 1.1p, but I do not consider this to be a representative level of earnings. Pass(ish)

6 -Yield - no dividend was declared in FY10. However, they intend to embrace a modest, but progressive, dividend commencing with the FY11 interims (see below). Fail, but potential to Pass

7 - ROE - was 7% in FY10. Given that the Company has been acquisitive in the past couple of years, there will be a time lag in seeing profits come through at the appropriate levels. Whilst the current level of profitability is not as high as we would like, it is important to remember that it does not represent the finished product. As work in progress, it gets a Marginal Pass.

8 - Directors - the two executive directors held 8.2m (£2.3m) of shares between them at February 2010. The directors had reasonable basic salaries, but generous bonus arrangements, linked to PBT targets, which will be good for shareholders if set at the right levels. Pass.